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LLC vs Corporation Taxes

LLC vs Corporation Taxes
Ines Zemelman, EA
09 September 2021

When starting a business, selecting a business structure is among the many decisions you need to make. A business, by default, is either owned by multiple partners (general partnerships) or by a single proprietor (sole proprietorships). These may seem like the simplest ways to organize a business, but there is a major drawback: they do not separate business owners from their businesses. 

Partner or sole proprietor businesses may be liable for personal assets if they're sued or can't pay their bills. Because Limited Liability Companies (LLC) and C corporations, also known as corporations, minimize each owner's personal liability, they are popular business structures. They are, however, quite different when it comes to taxation.

Corporation taxes

A corporation can be defined in two different ways depending on whether it is a C corporation or an S corporation. In the beginning, every corporation is a C corporation. The Internal Revenue Service allows some corporations to elect to be taxed as S corporations by filing Form 2553 with the IRS. 

With regards to C Corporation, the tax return is filed annually by corporations and the income tax is paid on the corporation's profits. Shareholders pay personal income tax on distributions from corporations that distribute part or all of profits to shareholders in the form of dividends. Due to the fact that corporations and their shareholders are both taxed on their distributions, C corporations face double taxation more often than S corporations and LLCs.

Unlike C corporations, S corporations are not taxed on their earnings. By contrast, corporate profits are rather passed through to shareholders' tax returns, and each shareholder must pay personal income tax on their portion. Due to this reason, S corporations are referred to as "pass-through entities." To qualify for S corporation taxation, corporations must meet the following requirements:

  1. No more than 100 shareholders are allowed.
  2. A shareholder cannot be a partnership, a corporation, or a non-resident alien.
  3. Only one category of stock can exist.

LLC taxes

There is a different tax treatment for limited liability companies as opposed to corporations. Taxation for LLCs is a pass-through arrangement. When a business has a pass-through taxation structure, its income and losses pass through to the owners' personal tax returns instead of recording on the business's tax return. Because of this, corporation profits are taxed at the individual taxpayer's rate. LLCs with a single member are typically taxed as sole proprietorships. A business owner's personal tax return includes profits, losses, or deductions incurred in the course of running the business that reduces taxable income. Multiple-member LLCs are taxed as partnerships, meaning each member reports profits and losses on their personal tax returns.

C corporations are subject to double taxation due to needing to distribute all company income to owners' tax returns. LLCs avoid this problem by passing all company income to the owners' individual tax returns.

Is it possible to tax an LLC like a corporation? 

The IRS does not classify LLC as a separate tax entity.  The company may instead choose from three different classifications:

Unless these companies opt to be taxed as corporations, LLCs are treated as disregarded entities. The LLC tax form appears on Schedule C. 

  • Anyone can elect to have their LLC treated as a C corporation by filing IRS Form 8832 with the IRS. 
  • In order to be taxed as an S corporation, an LLC must meet the requirements for electing corporate taxation and filing Form 2553

What is Form 1099? 

Business owners who pay independent contractors (non-employees) during the tax year should file Form 1099 with the IRS to document that payment. When your business purchases products, hire services, or pays rent to anyone or a limited liability company (LLC) for more than $600 in a calendar year, you are required to file a 1099 form.

One of the most frequently asked questions is whether a corporation taxed as an LLC receives 1099? Simply put: An LLC filing as a corporation is not required to issue 1099. All other contractors that are set up as limited liability companies (but don't file as corporations for tax purposes), will be required to file the 1099 form.

Corporation Pros and Cons

Establishing and operating an S corporation comes with distinct advantages and disadvantages. Here are a few pros and cons:

Pros:

  • Corporations protect individuals from liability
  • Pass through tax structure allows for personal tax returns since the corporation pays no tax
  • Creditors, suppliers, and investors may think more highly of your business
  • Companies pay dividends to their employees

Cons:

  • S corporations may be taxed at the corporate levels; some states do not tax them at the personal levels.
  • There can be more fees associated with S corporations than with LLCs.
  • Corporate governance rules are more complex for U.S. companies including strict IRS scrutiny.
  • Having less control is a disadvantage for the owner.

LLC Pros and Cons

The operation and formation of a limited liability company come with distinct advantages and disadvantages.

Pros:

  • LLCs confers limited liability, so owners are not involved in lawsuits or debts related to the company.
  • LLCs provide tax benefits to their owners, as tax returns for LLC income and losses are generally filed on the owner's personal tax returns thus avoiding double taxation.
  • Taxing LLCs as disregarded entities now can be followed by changing to corporate tax status later.

Cons:

  • Establishment costs are higher than for sole proprietorships and partnerships.
  • Reports must be filed annual, with fees running into the hundreds of dollars.
  • Investments from sources other than banks are not possible.

The structure isn't a single answer that fits every business; every organization has its own needs. To determine what structure is best for your needs, you must consider your financial situation and future plans. Ensure you weigh your options carefully before making a decision. Consult a certified public accountant with experience in the taxation of small businesses if you're unsure.

Hire a professional accountant

As soon as your company is established, we recommend that you seek professional tax guidance. It is helpful to hire a certified public accountant or tax professional to keep your company in compliance with the state and federal laws, but it will give you access to an advisor if you have other questions about your business.

Ines Zemelman, EA
Founder of TFX